U.S. Supreme Court Rules Against Debtors in Second Mortgage Cases

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Jun 10, 2015

U.S. Supreme Court Rules Against Debtors in Second Mortgage Cases

Posted By
Mahir Nisar Attorney at Law

Many New York homeowners are faced with two mortgages they can no longer
afford to pay. In many cases, the amount they owe to the bank far exceeds
the current market value of their homes. In order to avoid foreclosure,
debtors frequently turn to the federal bankruptcy courts. But a recent
U.S. Supreme Court decision should serve as a warning to homeowners that
even “underwater” mortgages may not be invalidated in a bankruptcy
proceeding.

Bank of America, N.A. v. Caulkett

This case involves two separate bankruptcy proceedings. The debtor in each
case has two mortgages on their respective homes. Bank of America holds
the junior (second) mortgage in each case.

Both homes are “underwater,” that is their current market value
is less than the outstanding balance on the senior (first) mortgage. For
example, in one of the cases, the debtor has a home presently valued at
$93,000, but he still owes $183,000 on his first mortgage and $47,000
on the second mortgage to Bank of America. In other words, if the first
bank were to foreclose and sell the property, it would not receive enough
to cover the balance, and consequently, Bank of America would receive
nothing for the second mortgage.

The debtors sought bankruptcy protection under Chapter 7 and asked the
court to void (or “strip off”) the second mortgages. The bankruptcy
court granted the motions. Bank of America appealed to the U.S. 11th Circuit
Court of Appeals in Atlanta, which upheld the bankruptcy judge's decisions.
The U.S. Supreme Court then agreed to hear a further appeal from Bank
of America.

The Supreme Court appeal centered on the wording of the bankruptcy code
itself, which says a mortgage or similar lien is void if it is not an
“allowed secured claim.” Specifically, the debtors and Bank
of America disagreed over whether the second mortgages at issue here were
“secured” claims. The bankruptcy court and the 11th Circuit
held Bank of America's claims were not secured, because the value
of its interest in the homes was zero.

The Supreme Court disagreed, however, citing its decision in a 1992 case
involving a similar situation. The prior case dealt with a partially underwater
mortgage—one where the debtor sought to reduce the mortgage to then-current
market value of the house. The Supreme Court ruled against the debtor,
holding the mortgage was still an “allowed secured claim,”
even if the actual selling price of the property would be insufficient
to cover the debt.

In the present cases, the debtors argued the Court should grant them relief
because their mortgages are wholly underwater, not partially as was the
case in 1992. Justice Clarence Thomas,
writing for the Supreme Court, said the Court would “decline to adopt this distinction.”
Justice Thomas noted under the debtors' suggested approach, a bankruptcy
court could strip a second mortgage if it valued the property at $1 less
than the value of the first mortgage, but not $1 more. “Given the
constantly shifting value of real property,” Justice Thomas observed,
“this reading could lead to arbitrary results.”

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